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Nobel Prize for Stock Option Model

Robert Merton of Harvard University and Myron Scholes of Stanford University have won the Nobel Prize in economics for a method for figuring the price of stock options and other securities based on underlying assets. Economists say the duo's 24-year-old formula has transformed today's financial markets.

The Nobel committee of the Bank of Sweden announced this morning that it had recognized the pair for a formula that calculates the value of a stock option, which is the right to purchase stock in the future at a preset price. Thousands of investors trade derivatives such as stock options and mortgage-backed securities every day. The Nobel committee credited the winners, along with late economist Fischer Black, for laying "the foundation for the rapid growth of markets for derivatives in the last 10 years." According to the Associated Press, such derivatives are now a $70 trillion global market. On the other hand, bad bets on derivatives brought down Barings, Britain's oldest bank, and drove Orange County, California, into bankruptcy.

By creating models in which an idealized trader borrowed money and bought stock, Black and Sholes derived a mathematical formula for the real value of the option. Black and Scholes published their finding in May 1973, a month after the first modern options exchange opened in Chicago. Perhaps because of that timing, Stephen Ross of Yale University has described the formula as "the most successful theory not only in finance but in all economics."